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More On Legal & Compliance

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Client Commission Practices and Soft Dollars
RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.

Agency and Principal Transactions
In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.

Senators on Tuesday took Gary Gensler, chairman of the Commodity Futures Trading Commission, to task over failed brokerage firm MF Global and his decision on Nov. 5 to recuse himself from investigating the firm.

At a hearing held by the Senate Banking Committee, in which senators grilled regulators on their progress in implementing the Dodd-Frank Act, Sen. Richard Shelby, R-Ala., ranking member on the committee, said in his opening remarks that when the act was passed, “the American people were promised that financial regulators would have all the tools and powers they need to properly regulate financial institutions and to protect investors and consumers. Unfortunately for the American people, more powers and more tools cannot help when regulators fail to do their jobs.” This lesson, Shelby went on to say, “is vividly demonstrated” by the CFTC’s “failed regulation of MF Global.”

Thirty-seven days have passed since MF Global filed for bankruptcy and more than $1 billion in customer funds are still missing, Shelby said, and “it is unclear how much longer customers must wait while a bewildered CFTC searches for their money.” On Tuesday, two employees sued MF Global executives over the losses.

Sen. Tim Johnson (left), D-S.D., chairman of the committee, said at the hearing that his South Dakota constituents have been sending letters to his office inquiring about reports from the MF Global bankruptcy trustee that as much as $1.2 billion in customer funds is missing.

Said Johnson to Gensler and SEC Chairman Mary Schapiro: “What is being done to track down the missing funds?”

Gensler replied that while he has recused himself from “participating in matters” regarding MF Global, in regards to the importance of protecting customer funds, Gensler noted that the CFTC on Monday voted, 5-0, to restrict how brokers can invest customer funds in money market funds and banned investments in foreign sovereign debt—the wrong bets that brought down MF Global. The rule was dubbed by CFTC Commissioner Bart Chilton as the “MF rule.”

Schapiro told Johnson that only a small portion of securities accounts–400–were related to the MF Global collapse compared to “many thousands” of futures accounts. However, she said, the SEC is looking at its rules regarding broker-dealers’ custody practices, to see if the agency can "bolster" these rules. She also noted a pending Financial Industry Regulatory Authority rule that would bolster broker-dealers’ financial reporting requirements.

Gensler deferred to CFTC Commissioner Jill Somers to answer Johnson’s question about what’s being done to find the missing customer funds. Said Somers to Johnson: the CFTC “has dozens of auditors” that are working with trustees and staff and they are “tracing transactions” that went in and out of MF Global; the transactions, she said, are “very complex” not only because of the number of transactions but also the types.

In a later round of questioning, Shelby bluntly asked Gensler if the CFTC knew where the missing customer funds were. Gensler again deferred to Somers. Her reply: “We’re working with forensic accountants to locate the missing customer funds. We have not located all of the funds.”

Shelby then asked Gensler why he recused himself from investigating MF Global.

Gensler replied that when the investigation of MF Global turned from a company investigation to an enforcement matter that focused on his former boss at Goldman Sachs, Jon Corzine, MF Global’s CEO, CFTC attorneys “didn’t see a reason” why he should continue. “I didn’t want my participation to be a distraction” to the investigation, Gensler said.

After hearing Gensler’s explanation, Sen. Mike Johanns, R-Neb., told Gensler that “your non-participation makes no sense to me.” Why, he asked “would you be a distraction” to the investigation? “What it feels like up here is that when this [investigation] got uncomfortable because money isn’t there that should be there, you don’t want to come up here and answer questions. To me it looks like you’re ducking the responsibilities of your job.”

Shelby has asked the CFTC’s inspector general to examine the CFTC’s oversight and regulation of MF Global, and to determine whether Gensler’s recusal was “appropriate” and whether Gensler “should have recused himself much earlier in the process.” In the absence of a committee investigation, Shelby said, “the IG’s examination will help determine whether MF Global received special consideration by the CFTC.”

The House Agriculture Committee has subpoenaed Corzine to testify at a hearing on Thursday, while the House Financial Services Oversight and Investigations Subcommittee has scheduled a Dec. 15 hearing to delve into MF Global’s collapse.